Private Student Loan Co-Signers Rarely Let Off the Hook, CFPB Finds

Co-signers for private student loans have had significant difficulty handing off the obligation to the primary borrower, despite what the lenders’ marketing materials say, according to a report issued Thursday by the Consumer Financial Protection Bureau.

Of those who applied for release from their co-signing agreement, 90% were rejected, the CFPB found. The report also says lenders make the requirements for release hard or impossible to find, and rarely explain their reasons for rejection.

Co-signers agree to pay a student loan if the primary borrower fails to pay. In addition to the liability of the loan itself, co-signers may find their credit scores take a hit if the loan is improperly handled because the loan appears on their credit reports. So there’s ample reason for co-signers to free themselves from the agreement. Once a student has graduated, is earning a paycheck and reliably making payments, the necessity of a co-signer is significantly decreased. Co-signer release is often advertised as a feature of private student loans.

But in reality, there’s little chance for co-signers to free themselves, the CFPB says.

“Our analysis of responses to the co-signer policy information request reveals that a miniscule portion of borrowers with loans that include a co-signer release actually obtained one,” it said in the report.

The issue is critical for parents and other co-signers, particularly because nearly all private loans now require a co-signer. Back in 2008, 67% of private student loans were co-signed — by 2011, more than 90% of private student loans were co-signed.

The CFPB also warned parents about other provisions of private student loans. Some lenders have a list of criteria that permanently bars co-signers from release, such as any request for loan forbearance. Meanwhile, many agreements call for “auto-default” if the co-signer dies or declares bankruptcy, meaning the student is required to repay the loan in full immediately.

“Parents and grandparents put their financial futures on the line by co-signing private student loans to help family members achieve the dream of higher education,” said CFPB Director Richard Cordray. “Responsible borrowers and their co-signers should have clear information and standards for releasing the co-signer if the time is right. We’re concerned that the broken co-signer release process is leaving responsible consumers at risk of damaged credit or auto-default distress.”

The findings in the CFPB report:

Companies rejected 90% of consumers who applied for co-signer release: Many private student lenders advertise options to release a co-signer from a private student loan. However, an analysis of industry responses to the CFPB’s information request found that the lenders and servicers surveyed granted very few releases — of those borrowers who applied for co-signer release, 90% were rejected.

Consumers left in the dark on co-signer release criteria: The CFPB found that consumers have little information on the specific borrower criteria needed to obtain a co-signer release. Consumers reported being confused about their eligibility for obtaining a co-signer release, as well as not understanding why they had been denied.

Most private student loan contracts continue to contain auto-default clauses: Last year, the CFPB reported that private student loan servicers were putting borrowers in default when a co-signer died or filed for bankruptcy, even when their loans were otherwise in good standing. Following that report, some financial institutions stated that they would no longer hit borrowers with auto-defaults. The CFPB’s analysis of private student loan contracts, however, found that most private student loan contracts continue to include auto-default clauses.

Borrowers are at risk when loans are sold and packaged by Wall Street: Even if individual companies state that they will not trigger auto-defaults in certain cases, loans are often sold to other banks and securitized on Wall Street. This puts borrowers at risk for the loan being triggered for an auto-default with the new owner.

Company policies can permanently disqualify borrowers from co-signer release: Student loan borrowers reported that some companies’ policies penalize or disqualify borrowers who prepay their loans and are in good standing. Some companies also disqualify borrowers from releasing a co-signer if the consumer accepts the servicer’s offer of postponing payment through forbearance. These company policies can permanently ban a consumer from seeking co-signer release for the life of the loan and penalize consumers that may have graduated during tough economic times.

Potentially harmful clauses found in the fine print: In addition to auto-default clauses, the CFPB found other potentially harmful clauses hidden in fine print of some loans including “universal default” clauses. Financial institutions use these clauses to trigger a default if the borrower or co-signer is not in good standing on another loan with the institution, such as a mortgage or auto loan, that is unrelated to the consumer’s payment behavior on the student loan. These clauses can increase the risk of default for both the borrower and co-signer.